Stock-Picking Lessons From a Pig Farmer

Editor's note: This was originally published on RealMoney. It is being republished as a bonus for readers.

Today I want to introduce you to one of my oldest friends. I first met this fine fellow back in 1988 as a rookie stockbroker. I will spare you the horror stories of cold-calling with stock ideas from the research department. They gave us really cool scripts to call potential clients with, and they were effective to a degree.

The problem is the stock ideas were terrible. It was hard to build a practice selling stocks that had terrible fundamentals and were overpriced. My frustration level was high.

At the time, a man who became something of a lifelong mentor gave me an old photocopy of a 1978 article from Forbes magazine by John Train. It told the story of an investor who was having a hard time making money in the market. His broker introduced him to a client who had done extraordinarily well over the years.

He met Mr. Womack, the pig farmer. Mr. Womack had been investing for 40 years and was consistently profitable. His secret was simple. He waited until he read in the news that the market was making new lows and all the experts were predicting the end of the world. He would select a package of stocks that had fallen below $10 a share in profitable companies that paid dividends.

When the market eventually recovered in a year or two and the news was full of ebullient predictions, he would drive back to town and sell them all. He thought of stocks like buying pigs. He bought them when they were cheap and sold them when they were expensive. Besides, as Mr. Womack pointed out, you do not have to feed stocks, and pigs do not pay dividends. That article is now 30 years old, and the advice is just as good today as it was then.

I sat down on Friday Oct. 17 and did a search for stocks that Mr. Womack might have liked. Given the current carnage in the markets, I came up with a pretty good list of stocks. I threw out all the financials and REITS because of the instability in those areas right now, and I still came up with a list of stocks that could be extremely rewarding over the next few years. Keep in mind that Mr. Womack held his stocks until the markets were roaring and everybody loved stocks again. That will probably take a few years, but you will collect handsome dividends while you are waiting.

The first company is one I liked at higher prices and like even more at these levels. CBS ( CBS) stock has been pummeled in the last few weeks. The stock has fallen almost 50% in just the last month. Advertising revenue and margins are dropping for the broadcasting company in the weak economy.

CBS recently announced that third-quarter profits would be below analysts' expectations. In addition, the company is caught in the crossfire of the ongoing Redstone family feud, and large blocks of stock have been sold by the contentious clan in recent weeks. However, the stock now trades at just 5 times earnings. The shares yield 12% at this level, and the dividend is not only safe, most expect the company will continue to raise it over the years. The balance sheet is sound with just 24% of capital in the form of debt, and it earns over 5 times its annual interest payments.

El Paso ( EP) operates in natural gas storage and transmission as well as exploration and production of gas. It owns or has an interest in 42,000 miles of pipeline that serves gas providers and electricity companies.

The combination of Hurricane Ike, falling gas prices and the recent massive deleveraging by energy- and commodity-related hedge funds has hit the share price hard. The stock is down 50% since the first week of September. The company is buying back shares and trades at just 8 times earnings. The dividend yield of over 2% is expected to grow at a 7% annual rate going forward. If that comes anywhere close to analyst-reduced estimates of $1.44 a year in 2009, the shares could easily recover the ground they lost in the last month.

These are the two that stood out when I looked over the list, but a lot of other companies trade at very low prices and pay respectable dividends at these levels.

Motorola ( MOT) shares have been decimated this year, falling all the way to below $6. The dividend yield is now almost 4%, and this company has enormous recovery potential.

Seagate Technologies ( STX) is the world's largest manufacturer of disk drives. The stock is below its 2002 low and sports a dividend yield of over 5%.

If, like Mr. Womack, you can ignore the current pessimistic market tone and are prepared to hold shares until the next bull market once again makes stocks acceptable cocktail-party chatter, buying a package of these beaten-down stocks that pay healthy dividends should be a rewarding strategy. As a bonus, you do not have to feed them, and neighbors are unlikely to complain when the wind shifts!

This was originally published on RealMoney on Oct. 20, 2008. For more information about subscribing to RealMoney, please click here.

At the time of publication, Melvin was long long Motorola and Seagate Technologies, although positions may change at any time.

Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.